Acquisition would challenge United Airlines in Denver, give Southwest international routes

July 31, 2009|By Julie Johnsson, TRIBUNE REPORTER

Southwest Airlines has launched a surprise bid to buy Frontier Airlines, a move that would make the carrier a powerful competitor to United Airlines in Denver and could speed Southwest's first expansion outside of the U.S.

Dallas-based Southwest said Thursday that it proposed to acquire Frontier for at least $113.6 million through an auction conducted by the U.S. Bankruptcy Court for the Southern District of New York.

The bid is higher than the $108.8 million offered earlier by Indianapolis-based Republic Airways Holdings Inc. to acquire Denver-based Frontier after it emerges from bankruptcy protection.

Southwest CEO Gary Kelly knows full well the strategic advantages to be gained through bankruptcy auctions. One of his first moves after becoming chief executive in 2004 was to outbid AirTran Airways for ATA Airlines' assets at Midway Airport later the same year, gaining control of 70 percent of the gates at the Chicago airport.

Southwest later acquired ATA's landing rights at New York's LaGuardia Airport, enabling it to launch service there for the first time in June.

If Kelly's Frontier gambit succeeds, Southwest will become about 10 percent larger overnight. It would control 33 percent of capacity in Denver, Frontier's hub, to United's 45 percent market share.

Southwest also would gain entrance to Washington's Reagan National Airport and to Atlanta, where Delta Air Lines and AirTran operate their largest hubs. And it could add international flights for the first time by acquiring Frontier's routes to Mexico and Costa Rica.

"It's a terribly bold but also brilliant strategic move," said aviation consultant Robert Mann, president of R.W. Mann and Co. "It answers the question about where is the next big block of Southwest growth coming from."

However, absorbing the acquisition would provide significant challenges to Southwest, which operates a single family of aircraft: a fleet of 544 Boeing 737 jets. Frontier operates a fleet of 51 Airbus narrow-body planes and owns a regional carrier, Lynx Aviation.

Southwest officials said they likely would ditch Frontier's fleet and transition flights to their Boeing jets over time. They haven't decided where Lynx fits into their plans.

Another headache: how to integrate Frontier's hub-and-spoke model into Southwest's system, where there are no hubs and aircraft fly point-to-point, from one city to the next.

But successfully competing with United out of Denver remains a far larger concern, Southwest executives said. "[United has] so many flights that when they operate a bank of flights out of Denver it essentially causes a solar eclipse," said Ron Ricks, Southwest's executive vice president for corporate services, in a conference call with reporters. "We know we will have our hands full."

For much of its 38-year history, Southwest avoided competing head-to-head with network carriers like American Airlines and United, aiming instead for secondary airports and leisure travelers seeking bargains.

As CEO, Kelly has not hesitated to take on the international carriers in their strongholds. For example, Southwest boosted its flying by 19 percent in United's 50 largest markets during the second quarter of 2009, Daniel McKenzie of Next Generation Equity Research LLC said in a recent research report.

Kelly has some key advantages: an airline with the strongest balance sheet of any large U.S. carrier, good employee morale and costs that are 29 percent below its peers. It can grab market share by keeping prices low and avoid charging fees that some passengers view as onerous.

"Domestically, Southwest is little by little squeezing the revenue life out of competitors -- a function of its lower costs," McKenzie said.

Because it is bidding for Frontier in an auction, Southwest runs the risk of losing to Republic or another late entrant.

But other low-cost carriers that might be tempted to enter the fray, such as JetBlue Airways, Spirit or Virgin America, don't have "the balance-sheet strength to outbid Southwest," said Vaughn Cordle, a former commercial airline pilot who is CEO and chief forecaster at AirlineForecasts LLC, a market research firm.

Although Frontier accepted Republic's terms, it agreed to establish an auction on Aug. 11 with its creditors committee to determine if better offers were available.

Under procedures established by the court, interested bidders must submit an initial proposal by Monday and a binding final offer by Aug. 10.

"Republic will respond to any binding offers in a court-approved auction procedure," said Carlo Bertolini, a Republic spokesman. "We're obviously studying [Southwest's] offer," he added, declining to say whether Republic would sweeten its bid.